A breakdown in communications between the CFDA and the Cemetery and Funeral Bureau has resulted in the California Attorney General filing a lawsuit that can be appropriately described as vitriolic. The “California lawsuit” could provide some valuable ‘what to avoid” lessons for regulators in other states.

In an unusual move, the Bureau went “public” last year by raising a number of issues with administration of the California Master Trust. Some of those issues did warrant an explanation. One issue involves the actions taken by the CFDA subsidiary in response to the 2000 market crash. The subsidiary implemented a plan to stabilize the master trust value after the collapse of a bond fund. Another issue regards the administration fees charged the master trust subsequent to the collapse of the bond fund. A third issue regards the subsidiary’s policy to pay a portion of the administration fees to participating funeral homes.

The CFDA countered with arguments of how its actions were within California law. Those arguments have merit, and were covered by this blog in July 2010. (See California Master Trust: serious missteps, but not another IFDA.) The CFDA proposed that the issues be reviewed in the context of relevant facts, having the Bureau apply thirty year old laws and regulations to the CMT’s circumstances. Instead, the California Attorney General adopted a “quick kill” strategy that employs a two prong attack: involve the consumer and apply the law strictly.

In taking the controversy to the consumer, the California AG has been disingenuous when using such terms as “conspiracy”, “concocted”, and “kickbacks”. In doing so, the AG may end up galvanizing the CMT membership, and getting anything but a quick kill.

The AG’s legal arguments are also somewhat disingenuous. As the title suggests, this blog entry will focus on the AG’s call for a truly independent trustee. In future entries, we will look at some of the AG’s other legal arguments.

In the “First Cause of Action” of the petition, the AG makes the argument for how the CFDA’s administrative subsidiary has assumed unlawful control over the preneed funeral trust. Granted, the CFDA may have gone too far in assuming control over the trustee’s appointment of agents (and discounted the interests of consumers with non-guaranteed contracts), but the AG ignores the fact the master trust consists of thousands of preneed contracts that originates in hundreds of funeral homes. This fact makes the fiduciary dependent upon the funeral home in a number of ways.

The trustee needs preneed contract data for accounting (much in the same way the regulator’s auditor is dependent on the same records to perform his job). As with other states’ master trusts, the association performed a vital role in providing crucial contract administration. Contrary to the AG’s citation to the California probate code, these are administrative functions the corporate fiduciary must delegate. The trustee cannot account for the preneed contract as a depository account.

The trustee also needs input when setting investment policies. The AG would suggest that the preneed trustee cannot look to the funeral home. This ignores that the vast majority of the preneed contracts are guaranteed, where the funeral home has assumed the risk of investment. It also flies in the face of the numerous “No Action Letters” issued by the Securities Exchange Commission.

The manner in which the trustee prepares trust tax returns impacts both the funeral home and consumer. The most efficient approach (Federal Form 1041QFT) has a cost to the funeral home. Consequently, the preneed fiduciary will want the funeral home’s approval.

The ‘independent preneed trustee’ may seem to be a quick and easy answer to regulators, but only if the courts ignore the facts and realities of administering a preneed trust.